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Climate change is emerging as a threat to the stability of the financial system. As a result the G20 finance ministers and Central Bank governors have asked the Financial Stability Board (FSB) to review how the financial sector can best take account of climate-related issues.

In order for investors, lenders, insurers and other financial stakeholders to build climate-related risks into their decisions, corporations need to provide relevant information. However, this information is currently not available and there is not a recognized framework for corporations to identify, quantity and report climate-related financial risks.

That is why, in December 2015, Mark Carney — the Chair of the FSB and Governor of the Bank of England — announced the formation of the Task Force on Climate-related Financial Disclosures (TCFD).

What are climate-related financial risks and opportunities?

Transition Risks: include the financial and reputational impact of failing to make a successful commercial transition to the low carbon economy. This covers the risks associated with:

Policy action that attempts to mitigate climate change or encourage adaptation to it

Litigation claims against companies for contributing to climate change, or failing to act on it

Physical Risks: include the financial impacts of the physical effects of climate change. These include disruption to a corporation’s operations and value chain from extreme weather such as floods, droughts, heatwaves and hurricanes. They also include risks from longer-term shifts in climate patterns. For example sustained higher temperatures leading to sea level rise.

The Task Force also outlined opportunities that can be realized through efforts to mitigate and adapt to climate change. For example:

Resource efficiency can reduce operating costs as well as curbing emissions

The cost of low emission energy sources is decreasing providing organizations with potential opportunities to reduce their energy costs

The recommendations are designed to generate decision-useful, forward-looking information on climate-related financial impacts and also to increase focus on the risks and opportunities related to a transition to a lower-carbon economy.

Core elements of recommendations

The recommendations are structured around four thematic areas: governance, strategy, risk management, and metrics and targets. For each element, the Task Force has defined an overarching recommendation, supported by a set of disclosures organizations should include in their reporting.

See breakout box below for details.

Principles

The recommendations establish a set of principles that are likely to shape the future expectations of investors, lenders, insurers and other data users.

Firstly, climate-related financial risk needs to be called out as an issue for Board attention. Secondly, corporations need to thoroughly assess their climate-related financial risks and opportunities ideally through scenario planning. Thirdly, corporations need to adapt their existing ERM/risk management processes to be effective at identifying and managing climate-related financial risk. Finally, data users and data preparers must work together to develop effective and decision-useful climate-related risk reporting metrics.

What does this mean?

Few corporations currently disclose climate-related financial risks. But that is set to change. Simply put, investors, lenders and insurers need much more, and much better, information on the financial risks corporations face from climate change.

The guidelines that have emerged, while voluntary, are likely — with the imprimatur of the FSB — to be accepted as de-facto global best practice. Or, at the very least, they will be used by regulators and stock exchanges to determine local standards. Board directors, as part of their fiduciary duty, will be expected to ensure they are applied so that the corporation reports appropriately on climate-related risk along with other material risks.

Conclusion

This is just the beginning of a new journey for both financial reporting and climate change. Expect further developments!